| GRAY TELEVISION INC Item 1A Risk Factors |
| Risks Related to Our Business We depend on advertising revenues, which fluctuate as a result of a number of factors and also experience seasonal fluctuations |
| Our main source of revenue is sales of advertising time and space |
| Our ability to sell advertising time and space depends on: • the health of the economy in the areas where our stations are located and in the nation as a whole; • the popularity of our programming; • changes in the makeup of the population in the areas where our stations are located; • pricing fluctuations in local and national advertising; • the activities of our competitors, including increased competition from other forms of advertising based mediums, particularly network, cable television, direct satellite television and the Internet; • the outbreak and duration of hostilities or the occurrence of terrorist attacks and the duration and extent of network preemption of regularly scheduled programming and decisions by advertisers to withdraw or delay planned advertising expenditures as a result of military action or terrorist attacks; and • other factors that may be beyond our control |
| For example, a labor dispute or other disruption at a major national advertiser, or a recession in a particular market, would make it more difficult to sell advertising time and space and could reduce our revenue |
| In addition, our results are subject to seasonal fluctuations, which typically result in second and fourth quarter broadcast operating income being greater than first and third quarter broadcast operating income |
| This seasonality is primarily attributable to increased expenditures by advertisers in the spring and in anticipation of holiday season spending and an increase in viewership during this period |
| Furthermore, revenues from political advertising are significantly higher in even-numbered years |
| Our flexibility is limited by the terms of our senior secured credit facilities |
| Our senior secured credit facility prevents us from taking certain actions and require us to meet certain tests |
| These limitations and tests include, without limitation, the following: • limitations on liens; • limitations on additional debt; • limitations on dividends and distributions; • limitations on management and consulting fees; • limitations on stock repurchases; • limitations on transactions with affiliates; • limitations on guarantees; • limitations on asset sales; • limitations on sale-leaseback transactions; 20 _________________________________________________________________ [75]Table of Contents • limitations on acquisitions; • limitations on changes in our business; • limitations on mergers and other corporate reorganizations; • limitations on loans, investments and advances, including investments in joint ventures and foreign subsidiaries; • financial ratio and condition tests; and • increases in our cost of borrowings or inability or unavailability of additional debt or equity capital |
| These restrictions and tests may prevent us from taking action that could increase the value of our securities, or may require actions that decrease the value of our securities |
| In addition, we may fail to meet the tests and thereby default under such senior secured credit facility (particularly if the industry continues to soften and thereby reduce our advertising revenues) |
| If we default on our obligations, creditors could require immediate payment of the obligations or foreclose on collateral |
| If this happened, we could be forced to sell assets or take other action that would reduce the value of our securities |
| Servicing our debt will require a significant amount of cash, and our ability to generate sufficient cash depends on many factors, some of which are beyond our control |
| Our ability to service our debt depends on our ability to generate significant cash flow in the future |
| This, to some extent, is subject to general economic, financial, competitive, legislative and regulatory factors as well as other factors that are beyond our control |
| We cannot assure you that our business will generate cash flow from operations, or that future borrowings will be available to us under our senior secured credit facility, or otherwise, in an amount sufficient to enable us to pay our debt or to fund other liquidity needs |
| If we are not able to generate sufficient cash flow to service our debt obligations, we may need to refinance or restructure our debt, sell assets, reduce or delay capital investments, or seek to raise additional capital |
| Additional debt or equity financing may not be available in sufficient amounts or on terms acceptable to us, or at all |
| If we are unable to implement one or more of these alternatives, we may not be able to service our debt obligations |
| We may be required to take an impairment charge on our goodwill and FCC licenses, which may have a material effect on the value of our total assets |
| As of December 31, 2005 the book value of our FCC licenses was dlra1dtta023 billion and the book value of our goodwill was dlra222dtta4 million in comparison to total assets of dlra1dtta525 billion |
| Not less than annually, we are required to evaluate our goodwill and FCC licenses to determine if the estimated fair value of these intangible assets is less than book value |
| If the estimated fair value of these intangible assets is less than book value, we will be required to record a non-cash expense to write down the book value of the intangible asset to the estimated fair value |
| We cannot make any assurances that any required impairment charges will not have a material effect on our total assets |
| We must purchase television programming in advance but cannot predict if a particular show will be popular enough to cover its cost |
| One of our most significant costs is television programming |
| If a particular program is not popular in relation to its costs, we may not be able to sell enough advertising time to cover the costs of the program |
| Since we purchase programming content from others, we also have little control over the costs of programming |
| We usually must purchase programming several years in advance, and may have to commit to purchase more than one year’s worth of programming |
| In addition, we may replace programs that are 21 _________________________________________________________________ [76]Table of Contents doing poorly before we have recaptured any significant portion of the costs we incurred, or fully expensed the costs for financial reporting purposes |
| We may lose a large amount of television programming if a network terminates its affiliation with us |
| Our business depends in large part on the success of our network affiliations |
| Each of our stations is affiliated with a major network pursuant to an affiliation agreement |
| Each affiliation agreement provides the affiliated station with the right to broadcast all programs transmitted by the network with which the station is affiliated |
| The NBC affiliation agreement for KKCO expires on July 30, 2006 |
| Our other affiliation agreements expire between January 1, 2012 and December 31, 2014 |
| If we do not enter into affiliation agreements to replace our expiring agreements, we may no longer be able to carry programming of the relevant network |
| This loss of programming would require us to obtain replacement programming, which may involve higher costs and which may not be as attractive to our target audiences |
| Furthermore, our concentration of CBS affiliates makes us sensitive to adverse changes in our business relationship with, and the general success of, CBS Network compensation is expected to decrease in future periods |
| Television station revenues are primarily derived from local, regional and national advertising and, to a much lesser extent, from network compensation |
| Cash payments are provided to us by networks in partial exchange for a substantial majority of the advertising time available for sale during the airing of network programs |
| Our network compensation has declined in recent years and will continue to decline in future years, reflecting an on-going phase-out by the networks of network compensation under our affiliation agreements |
| Increases in cable viewership and advertising could result in a decrease in our advertising revenues |
| Cable-originated programming is a significant competitor for viewers of broadcast television programming |
| The advertising share of cable networks has increased as a result of the growth in cable penetration (the percentage of television households which are connected to a cable system) |
| Increases in the advertising share of cable networks could result in a decrease in the advertising revenue at our television stations |
| Competition from other broadcasters and other sources may cause our advertising sales to go down or our costs to go up |
| Competition in the television industry exists on several levels: competition for audience; competition for programming, including news; and competition for advertisers |
| Additional factors that are material to a television station’s competitive position include signal coverage and assigned frequency |
| Stations compete for audience based on program popularity, which has a direct effect on advertising rates |
| A substantial portion of the daily programming on each of our stations is supplied by the network affiliate |
| During those periods, the stations are totally dependent upon the performance of the network programs to attract viewers |
| There can be no assurance that this programming will achieve or maintain satisfactory viewership levels in the future |
| Non-network time periods are programmed by the station with a combination of self-produced news, public affairs and other entertainment programming, including news and syndicated programs purchased for cash, cash and barter, or barter only, and involve significant costs |
| 22 _________________________________________________________________ [77]Table of Contents In addition, the development of methods of television transmission of video programming other than over-the-air broadcasting and, in particular, cable television have significantly altered competition for audiences in the television industry |
| These other transmission methods can increase competition for a broadcasting station by bringing into its market distant broadcasting signals not otherwise available to the station’s audience and also by serving as a distribution system for non-broadcasting programming |
| Technological innovation and the resulting proliferation of programming alternatives, such as home entertainment systems, ‘‘wireless cable’’ services, satellite master antenna television systems, low power television stations, television translator stations, direct broadcast satellite, video distribution services, pay-per-view and the Internet, have fractionalized television viewing audiences and have subjected free over-the-air television broadcast stations to new types of competition |
| Competition for programming involves negotiating with national program distributors or syndicators that sell first-run and rerun packages of programming |
| Each station competes against the broadcast station competitors in its market for exclusive access to off-network reruns, such as Seinfeld, and first-run product, such as Oprah |
| Cable systems generally do not compete with local stations for programming, although various national cable networks from time to time have acquired programs that would have otherwise been offered to local television stations |
| Competition exists for exclusive news stories and features as well |
| Advertising rates are based upon the size of the market in which the station operates, a station’s overall ratings, a program’s popularity among the viewers that an advertiser wishes to attract, the number of advertisers competing for the available time, the demographic makeup of the market served by the station, the availability of alternative advertising media in the market area, aggressive and knowledgeable sales forces and the development of projects, features and programs that tie advertiser messages to programming |
| Advertising revenues comprise the primary source of revenues for our stations |
| Our stations compete for advertising revenues with other television stations in their respective markets |
| The stations also compete for advertising revenues with other media, such as newspapers, radio stations, magazines, outdoor advertising, transit advertising, yellow page directories, direct mail, Internet and local cable systems |
| Competition for advertising dollars in the broadcasting industry occurs primarily within individual markets |
| Deregulation |
| Recent changes in law have also increased competition |
| The Telecommunications Act of 1996 created greater flexibility and removed some limits on station ownership |
| Telephone, cable and some other content providers are also free to provide video services in competition with us |
| Other proposed legislation would relax existing prohibitions on the simultaneous ownership of telephone and cable businesses |
| Future technology under development |
| Cable providers and direct broadcast satellite companies are developing new techniques that allow them to transmit more channels on their existing equipment |
| These so-called ‘‘video compression techniques’’ will reduce the cost of creating channels, and may lead to the division of the television industry into ever more specialized niche markets |
| Video compression is available to us as well, but competitors who target programming to such sharply defined markets may gain an advantage over us for television advertising revenues |
| Lowering the cost of creating channels may also encourage new competitors to enter our markets and compete with us for advertising revenue |
| Materiality of a Single Advertising Category Could Adversely Affect Our Business We derive a material portion of our ad revenue from the automotive industry |
| For example, approximately 26prca of total revenue came from the automotive category in 2005 |
| If automotive-related advertising revenue decreases, or if revenue from another ad category that constitutes a material portion 23 _________________________________________________________________ [78]Table of Contents of our stations’ revenue in a particular period were to decrease, our business and operating results could be adversely affected |
| The phased-in introduction of digital television will continue to require us to incur capital and operating costs and may expose us to increased competition |
| The conversion from analog to digital television services in the United States may have the following effects on us: Capital and operating costs |
| We will incur costs to replace equipment in our stations in order to provide digital television |
| Even with the flexible operating requirements, some of our stations will also incur increased utilities costs as a result of converting to digital operations |
| We cannot be certain we will be able to increase revenues to offset these additional costs |
| Conversion and programming costs |
| In addition to incurring costs to convert our stations from the current analog format to digital format, we also may incur additional costs to obtain programming for the additional channels made available by digital technology |
| Increased revenues from the additional channels may not make up for the conversion costs and additional programming expenses |
| Also, multiple channels programmed by other stations could increase competition in our markets |
| We are subject to the ongoing internal control provisions of Section 404 of the Sarbanes-Oxley Act of 2002 |
| Identification of material weaknesses in internal controls, if identified, could indicate a lack of proper controls to generate accurate financial statements |
| Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002 and related SEC rules, we are required to furnish a report of management’s assessment of the effectiveness of our internal controls as part of our Annual Report on Form 10-K Our auditors are required to attest to and report on management’s assessment, as well as provide a separate opinion |
| To issue our report, we document our internal control design and the testing processes that supports our evaluation and conclusion, and then we test and evaluate the results |
| There can be no assurance, however, that we will be able to remediate material weaknesses, if any, that may be identified in future periods, or maintain all of the controls necessary for continued compliance |
| There likewise can be no assurance that we will be able to retain sufficient skilled finance and accounting personnel, especially in light of the increased demand for such personnel among publicly traded companies |
| Pending litigation could adversely affect our ownership interest in Tarzian |
| Our equity investment in Tarzian represents shares which were originally held by the estate of Mary Tarzian, which we refer to as the Estate |
| Tarzian filed a complaint against the Estate claiming that Tarzian had a binding and enforceable contract to purchase these shares from the Estate |
| In addition, we were subject to a complaint filed by Tarzian claiming tortious interference with contract and seeking damages equal to the liquidation value of the shares |
| Although this case has been administratively closed, it is ongoing pending the final resolution of the litigation against the Estate |
| The Company believes it has meritorious defenses and intends to vigorously defend the lawsuit |
| Although the action has been adjudged on appeal in favor of the Estate, we cannot predict when the final resolution of this case, or the companion action against us for tortious interference, will occur |
| Our inability to integrate acquisitions successfully would adversely affect us |
| We have acquired 33 television stations since January 1, 1994 and in the future we may make additional acquisitions |
| In order to integrate successfully the businesses we acquire we will need to 24 _________________________________________________________________ [79]Table of Contents coordinate the management and administrative functions and sales, marketing and development efforts of each company |
| Combining companies presents a number of challenges, including integrating the management of companies that may have different approaches to sales and service, and the integration of a number of geographically separated facilities |
| In addition, integrating acquisitions requires substantial management time and attention and may distract management from our day-to-day business |
| If we cannot successfully integrate the businesses we have acquired and any future acquisitions, our business and results of operations could be adversely affected |
| Risks Related to Regulatory Matters Federal regulation of the broadcasting industry limits our operating flexibility |
| The FCC regulates our business, just as it does all other companies in the broadcasting industry |
| We must request and obtain FCC approval whenever we need a new license, seek to renew or assign a license, purchase a new station or transfer the control of one of our subsidiaries that holds a license |
| Our FCC licenses are critical to our operations; we cannot operate without them |
| We cannot be certain that the FCC will renew these licenses in the future or approve new acquisitions |
| Federal legislation and FCC rules have changed significantly in recent years and can be expected to continue to change |
| These changes may limit our ability to conduct our business in ways that we believe would be advantageous and may therefore affect our operating results |
| The FCC’s duopoly restrictions limit our ability to own and operate multiple television stations in the same market and our ability to own and operate a television station and newspaper in the same market |
| The FCC’s ownership rules generally prohibit us from owning or having ‘‘attributable interests’’ in television stations located in the same markets in which our stations are licensed |
| Accordingly, our ability to expand through acquisitions of additional stations in markets where we presently are operating is constrained by those rules |
| Under current FCC cross-ownership rules, we also are not allowed to own and operate a television station and a newspaper in the same market |